In many markets, buy and sell orders at the same price are automatically matched. Thus, for example, a first order to buy an item at a price of 100 and a second order to sell the same item at a price of 100 will, in such markets, result in a transaction in which some quantity of the item is sold at the specified price.
But in some markets, orders of equal price are not automatically matched. Rather, certain types of buy and sell orders, called “passive” orders, may co-exist at the same price without triggering a transaction. These passive orders do not trade unless “aggressed” against by a trader submitting a second type of order, called an “aggressive” order. Historically, a passive order to buy has been referred to as a “bid,” while a passive order to sell has been referred to as an “offer.” By contrast, an aggressive order to sell has been referred to as a “hit,” while an aggressive order to buy has been referred to as a “take” or “lift.”
This distinction between passive and aggressive orders is one of several characteristics that developed in certain markets to encourage market liquidity. In particular, since it is impossible to generate liquidity in a market without having someone first make a price, brokers historically sought to encourage traders to submit bids and offers by not charging them a commission if their orders resulted in a trade. Thus, passive bids and offers could not be matched even at the same price since neither the buyer nor the seller would pay commission.
In addition to commission-free trades, brokers in some markets also rewarded buyers and sellers by developing a number of trading protocols or conventions which granted certain buyers and sellers specified trading options or “rights.” One such convention is commonly referred to as “workup.” In general terms, this convention permits buyers and sellers to “work up” the size of a trade from the quantity traded as a result of an initial “hit” or “lift.”
Even before electronic trading, brokers utilized a substantial amount of technology to store and distribute real-time market information to their customers. More specifically, when a trader called a broker with a bid or offer for a given security, the broker typically entered the order into an electronic system which used the information to develop a picture of the prices and volumes available on the bid and offer sides of the market in that security. This information was distributed in real time to the broker's customers for display on small CRT screens on traders' desks. In addition, when a broker received an aggressive hit or lift order from a trader, the broker would similarly enter the aggressive order into the firm's electronic system. This would cause the CRT screens on traders' desks to flash, indicating to the market that a workup was in progress.
As noted, brokers typically entered bids and offers telephoned in by customers into the brokers' electronic systems as the orders were received. From time to time, however, a trader might call his or her broker and request that a bid or offer at a better price than the current best price in the market be kept “off the screen” and presented to less than the entire market, to see if such a bid or offer might stimulate trading interest.
When informed of the offscreen bid or offer, the potential counterparty might hit or lift it, which would cause a transaction to occur. When this happened, the broker might flash this transaction on the traders' screens and attempt to work up the trade further.
Alternatively, the potential counterparty might decline to hit or lift the off-the-screen bid or offer but instead counter with a price of his or her own. The trader that submitted the initial offscreen bid or offer might then choose to hit or lift this counter-price, resulting in a transaction, or choose to negotiate the price further with the potential counterparty.
As electronic trading has spread, some electronic platforms have been programmed to provide automated versions of trading conventions and practices like the ones described above. In some cases, however, a simple one-to-one translation from a voice practice to an electronic trading practice is not practical or advisable for commercial reasons. In such cases, it is desirable to modify the traditional voice protocol or practice to optimize its performance in an electronic trading environment.